The advantage of the large cap quality stock

Businessweek (and others) published a piece on the Coca-Cola bond offering that spoke to (1) the pace and size of debt being issued recently; and (2) strong investor interest resulting in extremely low absolute and relative yields.  The FT sums it up:

"Investors wrestling with a low yield environment are opting for the safety of owning company debt backed by solid balance sheets. That explains why companies such as McDonalds, IBM, Walt Disney and Procter & Gamble have sold paper at record low yields this year."

Large cap quality stocks (defined loosely as profitable, modestly leveraged, dividend paying large multi-nationals) are in a position to borrow very cheaply relative to the Treasury and LIBOR yield curves, and very cheaply on an absolute basis. 

As an example, Microsoft's 4% Feb 2021 bond has a yield of 2.39% which is only 10bps above the benchmark 10 yr US Treasury (source: TRACE).  To compare the absolute level against something, a quick number to grab is the EBITDA/EnterpriseValue of about 12.72% (source for all data is Yahoo! Finance unless otherwise stated).  

The obvious advantages of  raising debt is the cash to invest in efficiencies, growth, other companies, and their own stock.  Furthermore, these are not bad stocks to own right now in a variety of scenarios.  For example... 

• If we continue to see an environment of slow, but positive, U.S. growth in a zero-to-low rate environment due to continued uncertainty about  jobs, housing, the Euopean debt crisis, and political brinksmanship: then we continue to enjoy a healthy dividend (2.4% in the Microsoft example) and benefit from any stock buybacks.
• If conditions result in another recession: then we continue to enjoy the dividend (assuming it is not the end of the world... again) and some relative downside protection vs other more growthy stocks and more volatile risk assets.
• If economic conditions improve: then we may expect to enjoy not only stock buybacks but dividend hikes as earnings grow--and companies will have stockpiled cheap cash to deploy for that growth.

What are your thoughts on these stocks?

Disclosure: long position in Microsoft

Signs of a Canadian housing bubble?

Remember Crack Shack or Mansion?  While not quite as egregious as Vancouver, residential real estate prices in Toronto have become blog worthy.

Understanding labour statistics

A wonderful summary of the differences between the two key sources of labour statistics at the Worthwhile Canadian Initiative.  U.S. and Canadian approaches are discussed.

More on labour participation rates

I recently listened to a guest on Bloomberg Surveillance with Tom Keene and Ken Prewitt discussing how the drop in U.S. participation is nothing to be alarmed about because it is a function of baby boomer demographics.  Since the market is getting tougher and they are thinking about retirement anyway, they may have less attachment to the labour force. I looked at the Canadian data to see if this idea holds here.  The answer is no.  While overall participation rates have been dropping since the great recession, they have been on a steady up-trend for ages 55 and over.  Ten year chart below:

 

Yellow Media Cuts Dividend on Preferreds

Announced today with their Q4 earnings. Risk of a pre-packaged bankruptcy (or something along those lines) that wipes out the existing common and preferred shareholders seems more likely.  Doh.

One Year in a TFSA

Jan 19, 2011: Contribute $5,000 to TFSA account.

Jan 21, 2011: Buy 245 shares of iShares DEX Long Term Bond ETF, XLB, at $20.06.  Rationale: lots of negative headlines, it's the end of the world, yields are going to fall.

May 26, 2011: Sold 245 shares of XLB at $20.70, 5.0% total return.  Rationale:  yields have dropped 26bps (measured by Bank of Canada V39056), they probably won't go up, but probably can't go any lower.  Outcome: very very very wrong.  Yields dropped another 99bps to the end of the year with XLB posting a 15.6% total return.

June 2011: Bought 250 shares of iShares DEX HYBrid Bond ETF, XHB, at average price of $20.37.  Rationale: if yields are not going down anymore, perhaps this will put pressure on credit spreads.  Outcome: wrong again.  XHB was up less than 1% from the beginning of June to the end of the year despite the fall in Government yields and having a duration of over 6 yrs as spreads widened.

Aug 8, 2011: Sold 250 shares of XHB at $20.65, 2.6% total return.

Aug 8, 2011: Bought 950 shares of SilverBirch Energy, SBE, at $5.50.  Rationale: This was a spin-out from UTS after the take over by Total. Possibly sold for non-economic reasons (i.e. just didn't fit into their strategy for buying UTS). Significant ownership and board representation by West Face Capital and The Children's Investment Fund (presumably they know what they're doing?).  This is an oil sands exploration company, seems to go along with the idea of exposing yourself to positive surprises (see The Black Swan).  Outcome: finally right.  Teck Resources makes bid for SilverBirch to develop the 50% of two projects that they do not already own.

Jan 10, 2012: Sold 950 shares of SBE at $9.65, 75.5% return.

Good news, bad news: employment situation

Good News

Since its recession lows, the average work week has been increasing. Why is this important?  By a rough calculation, every 0.1 hrs equates to an annualized income of about $2B for the economy (0.1 hr/wk x 17mm workers x 23.5 $/hr x 52 wk/yr).

 

Bad News

While the unemployment rate has been trending downwards, the participation rate has been going down as well.  It looks like most of the improvement in this key headline rate has been from people dropping out of the workforce.  (The idea for this chart comes from a Brad DeLong chart).

How do you think consumers are feeling about their jobs?

Yellow Media Inc. Preferred Shares

There's a funny thing happening in Yellow Media's securities.  Others have spotted this idea too and commented elsewhere but here it is for those who have not focused on this (after losing over 97% of its value in 2011 this penny-stock may not be on people's radars anymore).

Catalyst
Two key events are likely to happen in March 2012:

1. Yellow will pay a quarterly dividend on its preferreds ($0.265625 on the series 1).
2. Yellow will convert the preferreds into common (at a ratio of 25/2 common shares per series 1 preferred share).

Outcome
At Friday's closing prices, this means that holders of series 1 preferred shares will get a $0.95 profit, or 43%. Link to spreadsheet.

Risks
The stock is priced how it is due to concerns about the viability of the business.  Yellow took on a mountain on debt during its life as a high flying income trust and continued to pay-out too much cash even after converting to a corporation (the dividend was discontinued in 2011).  Investors are concerned about management's ability to complete the transformation from a telephone book maker to an internet/e-media services company.

Potential
Can they survive?  If its lenders continue to support the business, there seems to be enough cashflow to continue servicing its debt:

• The company made $166mm of EBITDA (51.3% margin) in the three months ending September 30, 2011.
• (LTM EBITDA)/(Interest) was 6.1X, and (net debt)/(LTM EBITDA) was 2.5X. 

From a value perspective, let's assume book value per share is a good starting place.  Let's further assume that 100% of intangible assets will need to be written off and 10% of goodwill (they already wrote down $2.9B in Q3 2011).  That takes book value down to about $0.27.  If you believe all that, it is still about a 66% profit.  Link to spreadsheet.


What do you think of this opportunity?



Disclosures: I am looking at this opportunity and may buy series 1 preferred shares before the ex-dividend date.
UPDATE (1/31/2012): long position in preferred shares.

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